Brexit impact on UK construction: Hard exit from EU will see sector contract

In view of the failure of the UK’s politicians to find consensus on any withdrawal agreement, the possibility of the UK exiting the EU without a deal in place is becoming increasingly likely.

This is in spite of the fact that the only move that UK politicians have actually agreed on is that of ruling out a no-deal Brexit.

Although, this “hard” Brexit scenario could appeal to a large proportion of the UK public who voted to leave the EU in the 2016 referendum, it is a scenario that potentially causes the most disruption to the UK’s economy.

The UK would immediately be designated a ‘third country’, resulting in a high level of uncertainty about individual citizens’ rights and future immigration systems, and with freedom of movement coming to an immediate end.

In addition, without a customs agreement in place, there would likely be significant disruption in the supply chain in the short-term, at least for UK-based contractors importing materials and equipment from the EU, and there is also the possibility of a sharp depreciation in the pound vis-à-vis the euro that would also push up costs of imported materials and equipment.

In late 2018, the Bank of England stated that a disorderly no-deal Brexit could result in “a deep and damaging recession”, including an economic contraction of up to 8% (in terms of the “maximum fall from the starting point”), while house prices could plummet by 30% and commercial property prices could drop by 48%. The Bank of England also added that in the worst-case scenario, interest rates could jump to 5.5%.

GlobalData views this outcome as being overly extreme, but it serves as an illustration of the extent to which a hard Brexit could impact the UK economy.

Although a hard Brexit would result in clear-cut exit from the EU, there would be a new phase of uncertainty; investors would potentially put on hold new developments or cancel projects outright until there was some clarity on the UK’s future position outside of the EU under a no-deal scenario. The commercial sector would be the hardest hit, with reduced investment in new office, retail and hospitality buildings, particularly for speculative developments.

Although the underlying drivers for construction works in residential and infrastructure construction would remain in place, project costs could spike in the short term. This could result in infrastructure projects becoming unviable and potentially result in contractors failing to deliver projects within budget. There is also a risk of interest rates being pushed higher in the event that a weaker pound drives up prices, and higher borrowing costs would hit the housing sector.

Further contributing to the downside risks to the construction industry stemming from a no-deal Brexit is the likely upheaval in the UK’s political environment. The government of Theresa May has failed to maintain control of the Brexit process, and a change in the leadership of the government is likely in 2019. There is also a high probability of a general election in 2019, which could potentially deliver a new government with different plans for a number of proposed infrastructure developments.

Under a hard Brexit, which could occur in the second quarter of 2019, GlobalData forecasts that the UK’s construction output would contract by 1.8% in 2019, the first negative outturn since 2012. This would be followed by a decline of 0.5% in 2020.

This assumes that construction in the commercial sector will contract by over 3% in 2019 and 2020, while industrial construction would fall by 2.2% a year during that period, and in the institutional sector there would be a marginal drop off in activity.

Construction in infrastructure and energy and utilities would continue to expand, albeit at a slower pace than under the managed exit scenario. With confidence taking a hit in the fallout from a hard Brexit, residential construction would also be impacted, with a decline of 1-2% a year in the next two years, compared to average growth of 7.3% a year in the past six years.

The forecast growth trend under the hard Brexit scenario assumes that the government manages quickly to create a sense of order, avoiding a chaotic and disorderly operating environment, particularly with respect to trade and with dealing with the employment status of EU nationals working in the UK. A much steeper contraction in construction output would follow in the event of a failure to enact policies and swiftly disseminate accurate information regarding changes in the regulatory environment.